Money and the Fed Unit 4 Notes

MONEY Task! – What is money? – What is the function of money? – What has served as money throughout history?

Money Money has Three Basic Functions: – 1. Medium of Exchange- enables us to carry out trade and commerce easily – 2. Standard of Value- allows us to measure and compare value using one scale – 3. Store of Value- it (usually) holds its value over time

Money Money also has Six Main Characteristics: – 1. Acceptability- in order for you to buy something, the seller must be willing to accept what you offer as payment – 2. Scarcity- needs to be scarce enough to be valued by buyers and sellers

– 4. Durability- if money is to serve as a store of value, it must be durable 3. Portability- in order to be convenient as a medium of exchange it must be portable

– 5. Divisibility- to be useful as a medium of exchange, money must be easily divided into smaller amounts – 6. Uniformity- a dollar is a dollar is a dollar. We take for granted that each dollar is the same as the next.

What Serves as Money? – Throughout history, many items such as: salt, shells, cattle, beads, fur, tobacco, gold, and silver have served as money – These are examples of commodity money– form of money that has some intrinsic value or alternate use Gold and silver have generally been preferred because they hold many of the characteristics of money

What about today? However, our money is no longer backed by precious metals such as gold and silver Fiat money- paper money decreed as legal tender, but not representing anything of intrinsic worth – Rather, money is accepted solely because we believe that it is worth something, and is backed by the “full faith and credit” of the United States government Trust me!

What is Currency and Money Supply? Currency- the bills and coins currently in circulation in the economy However, currency is only a part of the total money supply in the country Money Supply – total amount of currency, loans/credit, and other liquid instruments available in the economy at a given time

M1& M2 Money Supply M1 Money Supply is made up of: – Coins and bills (currency) – Checkable deposits (liquid assets) – Travelers Checks M2 Money Supply is made up of: – All of M1 – Less liquid assets such as savings deposits, money market accounts, etc. Discussion: Do we want a larger or smaller total money supply?

So how is that money (M1 and M2) transferred between people and managed? – By banks!

The Regional Banks of the Federal Reserve aZQ&list=PL2EVBfEJ5a_JPvnd463lXOKmqdzL1 9ygR aZQ&list=PL2EVBfEJ5a_JPvnd463lXOKmqdzL1 9ygR kHk&feature=c4-overview- vl&list=PL2EVBfEJ5a_JPvnd463lXOKmqdzL19y gR kHk&feature=c4-overview- vl&list=PL2EVBfEJ5a_JPvnd463lXOKmqdzL19y gR

The Banking System in a Nutshell: Fractional Reserve Banking- a system whereby banks keep a fraction of deposits in reserves but loan out the rest to businesses and consumers System allows our MONEY SUPPLY TO EXPAND!

Federal Reserve Reading Pg – Read 14.4 “What Tools Does Monetary Policy Use to Stabilize the Economy” Complete Sections A-D of “The Federal Reserve” Notes

Follow-Up Questions – Reread Pgs What is the Federal Reserve System? What is monetary policy? Why does the Fed use… – An easy-money policy? – A tight-money policy?

Catch Me If You Can fWn8 fWn8 Nek Nek

Monetary Policy- what is it? Monetary Policy- central bank policy aimed at regulating interest rates and the amount of money in circulation to influence the health and direction of the economy

The Federal Reserve (Fed) The Federal Reserve is America’s central bank, established in 1913 Congress gave the Fed enough power to act independently in regards to monetary policy

Structure of the Fed 1. Board of Governors – 7 member board that oversees the Fed from Washington D.C. – Appointed by the president and confirmed by the Senate for one 14 year term in office – President selects one governor to serve as chairman for 4 years – Responsible for the overall direction of monetary policy

Structure of the Fed 2. Regional Federal Reserve Banks – 12 regional banks – Carry out many of the day-to-day duties – Each regional bank overseen by a president

Structure of the Fed 3. Federal Open Market Committee (FOMC) – Consists of: All 7 governors from the Board of Governors 5 rotating regional fed presidents – **But always New York’s president – FOMC is the policymaking body of the Fed – Study economic information and decide what changes (if any) to make to monetary policy

Policies followed by Fed Easy Money Policy (Expansionary) – Fed expands the money supply trying to cause cheaper lending to stimulate economic growth – Interest rates lower but too much easy money policy leads to INFLATION Tight Money Policy (Contractionary) – Fed shrinks the money supply trying to cause lending to be more expensive to slow the economy – Interest rates rise but too much tight money policy leads to a RECESSION

Federal Reserve Reading Pg – Read the rest of14.4 “What Tools Does Monetary Policy Use to Stabilize the Economy” Complete Section E & F of “The Federal Reserve” Notes

Follow-Up Questions What are open-market operations? What is the reserve requirement? What is the discount rate? What is the purpose of these tools?

3 Main Tools of the Fed 1. Open Market Operations- the buying and selling of government securities in the bond market (most used tool) – Easy-Money Policy: Fed bond traders BUY government securities, which increases the money supply – Tight-Money Policy: Fed bond traders SELL government securities, which decreases the money supply

2. Reserve requirement- the minimum percentage of deposits that banks must keep in reserve at all times (least used tool) – Easy-Money Policy: Fed LOWERS REQUIREMENT, which increases the money supply – Tight-Money Policy: Fed INCREASES REQUIREMENT, which decreases the money supply

3. The Discount Rate- the interest rate the Fed charges on loans to private banks (last tool in their toolbox) – This tool leads to the Fed being known as the “lender of last resort” – Controlled by the Board of Governors – Easy-Money Policy: Fed LOWERS rate, which increases the money supply – Tight-Money Policy: Fed RAISES rate, which decreases the money supply

The Fourth “Tool” 4. Federal Funds Rate- the interest rate that banks charge one another for quick (overnight) loans Banks set this rate, so this is NOT a monetary policy tool HOWEVER, the Fed sets a target rate based on its view of the economy & uses OMO to nudge the rate towards the target! – The Federal Funds Rate affects the interest rate on everything: credit cards, mortgages, savings accounts, bonds, etc.

Review of Monetary Policy How does the Fed stimulate the economy?

UNIT #5 Fed REVIEW: Define monetary policy in your own words. If the Fed wanted to increase the money supply using the discount rate, what would they do? Would the Fed be attempting to stimulate or slow down the economy? If the Fed wanted to decrease the money supply using reserve requirement, what would they do? What would happen to interest rates? If the Fed wanted to increase the money supply using open market operations, what would they do? Would this be considered easy or tight money policy? What is the relationship between interest rates and the amount of credit demanded?

How much do banks need to keep on reserves? Pat’s $1000 Deposited Pat’s $ $200 in reserve LOAN Kim’s $800 for School books Pat’s $1000 – $200 in reserve PSU deposits $800 – $160 in reserve LOAN Dave’s $640 for New TV **In a sense, as banks continuously lend money that is not in reserves, they are “creating money” in the money supply. This lending is increasing the flow of money that ordinarily wouldn’t be able to happen!**